Who Really Robbed FDIC $6 billion

I asked on Monday who robbed FDIC $6 billion from the IndyMac Bank failure. Too bad more of you didn’t chime in. Come on, don’t be shy. It’s not fun if it’s just me yapping all the time. Anyway, here are my thoughts.

1. Defaulted Borrowers. IndyMac took in deposits and lent out the money as home loans. That’s what a Savings & Loan does. Every borrower signed a promise saying they will make payments by the payment schedule. Not all borrowers are fulfilling their promise though. Because of these defaulted borrowers, IndyMac collapsed. Since FDIC has to make the depositors whole, the defaulted borrowers in effect took money from FDIC. Some borrowers may not have wanted the money in the first place. They’ve been marketed to by IndyMac, misled by realtors, mortgage brokers and what not, but that doesn’t change the fact that they took the money from IndyMac and they are not paying the money back as promised. In the end, they took and kept the money from FDIC. Imagine if all IndyMac’s loans were current, the bank would not have failed.

A related interesting question is, will FDIC do wholesale loan modification for IndyMac’s borrowers? Sheila Bair, the head of FDIC, often criticized banks for not doing loan modifications fast enough. Now that FDIC owns IndyMac’s mortgage portfolio, will it foreclose on defaulted borrowers? If it doesn’t, will that become an open invitation for more defaults? Or will it forgive loan balances and keep the borrowers in their homes? If FDIC doesn’t do anything differently than another bank, then all the criticisms on other banks are just empty talk. Other banks must be watching closely what FDIC does to IndyMac’s loans now that FDIC’s own money is on the line.

[Update] A Google search found this on the Wall Street Journal: FDIC’s Bair Halts Some Foreclosures in IndyMac Portfolio. If I have a mortgage with IndyMac, I’d stop paying immediately, knowing that Bair will not let IndyMac Federal foreclose on me. I’d wait until IndyMac Federal comes to me with a principal reduction offer. Then I start paying again.

2. Depositors. This may be a surprise, but depositors also robbed FDIC. Before it was closed by the authorities, IndyMac’s rates on deposits were among the highest in the country. People flocked to IndyMac for the high rates. The interests IndyMac paid to the depositors actually turned out to be FDIC’s money. IndyMac had $19 billion deposit when it was closed. If those deposits earned on average 2% a year more than say what Bank of America offered in the last five years, that’s $1.9 billion of FDIC’s money right there. Although it sounds unfair to the bank customers, if a bank wants to be strong, it cannot pay super high interests to its customers.

FDIC should change its policy and add a risk sharing component to its insurance. If a bank fails and FDIC has to cover the loss, then all current or past depositors should pay back the excess interest they earned from the bank X years prior to the failure. This is not too hard to implement. The bank has records on who the customers are. This risk sharing does not diminish the value of FDIC insurance either. The principal and regular interests are still protected. Only the excess, above-market interests have to be paid back. This way the customers will not chase the high rates as much as they do now.

Let’s also take a look at some other players who had a role in the bank collapse but didn’t necessarily take FDIC’s money.

3. IndyMac Management. IndyMac Management took the wrong risk. It thought the Alt-A mortgages were a well-compensated risk but it turned out that the risk was vastly under-estimated. Although IndyMac Management’s poor decisions caused the bank’s failure, I doubt that the management took in much substantial amount for themselves relative to the $6 billion number. Even if we claw back 100% of management’s salary and bonus for the last five years, it’s probably just a small percentage compared to the $6 billion cost of the bank failure. They took some of FDIC’s money, but not much.

4. Senator Charles Schumer. Senator Charles Schumer is like the child who yelled the emperor had no clothes. He publicly released a letter in June questioning IndyMac’s viability. This publicity prompted a lot of depositors to withdraw their money from IndyMac. IndyMac wasn’t able to withstand that kind of bank run. Senator Schumer might have pushed IndyMac over the edge but he didn’t take FDIC’s money.

5. Short Sellers of IndyMac Stock. A reader pointed to short sellers who drove IndyMac’s stock price to the pennies. Short sellers profited from the stock decline but their profit came from other investors who bought IndyMac’s shares at higher prices. They didn’t take FDIC’s money.

6. Office of Thrift Supervision (OTS). OTS is IndyMac’s primary regulator. It should’ve watched more closely on IndyMac and either rein it in or close it down before the problem got out of hands. If it had taken actions sooner, FDIC’s loss wouldn’t be so large. However, OTS didn’t take FDIC’s money.

7. FDIC. FDIC is a secondary regulator for IndyMac. It provides deposit insurance to IndyMac. A threat of pulling IndyMac’s insurance would have stopped IndyMac dead in the tracks. But FDIC didn’t do that. They stood by watching IndyMac handing out its money to borrowers and depositors. If FDIC were a private insurance company, I bet they wouldn’t be that passive. Because by definition you can’t incur a loss by taking money from yourself, FDIC didn’t take FDIC’s money.

8. Allan Greenspan, George Bush, … The policy may be wrong which caused IndyMac’s failure and FDIC’s loss, but they didn’t take FDIC’s money.

9. Real Estate Sellers. This one is a little tough. The real estate sellers sold their homes in arm-length transactions for market prices at the time. The prices they got turned out to be pretty good in retrospect. To the extent they sold to IndyMac’s borrowers who now defaulted or will likely to default soon, you can argue that the defaulted borrowers passed FDIC’s money to those sellers. But because money is fungible, you can also argue everything the defaulted borrowers bought was bought with FDIC’s money. And those who accepted FDIC’s money from the defaulted borrowers bought a lot of other stuff with FDIC’s money. By six degrees of separation, even my salary has a small part of FDIC’s money. But I won’t go that far. The real estate sellers didn’t have control over which lender the buyers chose or whether the buyers would default. Between two sellers, say one sold to a buyer who borrowed from Bank of America and didn’t default and the other sold to a buyer who borrowed from IndyMac and defaulted, if we say the former didn’t take FDIC’s money but the latter did, that’s just a luck of the draw. So I say stop at the defaulted borrowers and not chase the money further down the chain.

Comments

Depositors? No, absolutely no way. Depositors provided capital that could possibly have SAVED IndyMac (if its management had been wiser in where they put the money). The depositors didn’t set the interest rates; if anything, as more depositors flocked in the bank would be inclined to lower their rates.

Now, the people who participated in the “run” on IndyMac could be accused of robbing the FDIC. That’s actually plausible, and without a doubt THEY are a subset of the depositors. But frankly, the bank had agreed to provide their money on demand, so they were well within their rights.

The FDIC itself (well, and Congress) set a large number of the rules that make this happen; for example, if it were possible for a bank to charge a “load fee” (or if the FDIC imposed a tax on withdrawals) during a run, the run would have been _vastly_ smaller.

And then there’s the Federal Reserve’s inflationary money supply policies… Those are what inflated the bubble in the first place, almost at the same time as they cushioned the landing from the dot-com/9-11 crash.

But either way, I’m definitely blaming the GENERAL problem on opaque risk-taking with mortgage-based securities.

The savings market is strange in that the FDIC covers any downside risks in your choice of where to deposit your money. I posit that Savings should be “more like” (but not exactly like) a bond market in that if you get a higher return if you are willing to take a higher risk, but you get a lower return if you want low risk.

I wouldn’t advocate a $0 insurance, but $100,000 insurance seems high. Maybe $25,000 is enough. If you have $100,000 in cash, (a) you’re stupid to put all of that in cash instead of Treasuries, money market, low risk bonds, etc, etc and (b) if you have $100,000, you’re likely to be able to withstand a bank failure.

What we need is catastrophic insurance for those who cannot afford to have catastrophic things happen to their cash reserves. So $25,000 sounds reasonable. $100,000 sounds way unreasonable and hides the true cost of putting your deposits in a risky bank.

The depositors entered into a contract agreement with the bank. They held up their end of the deal: they let the bank use their money under the condition that it was FDIC insured. Customers taking advantage of an offer from a bank is not theft. It’s not their job to determine that the bank is taking absurd risks. That’s the job of the insurer.

Senator Charles Schumer is like the child who yelled the emperor had no clothes.

You’ve got your metaphor wrong. The child was the only one who was innocent/naive/not afraid to speak truth to power.

The metaphor you are looking for here is shouting “Fire!” in a crowded theatre. Even if it is true, the stampede you cause may be worse than the fire.

Short Sellers of IndyMac Stock. A reader pointed to short sellers who drove IndyMac’s stock price to the pennies. Short sellers profited from the stock decline but their profit came from other investors who bought IndyMac’s shares at higher prices. They didn’t take FDIC’s money.

You got this one right. Normal short sellers are betting against the people still in the theatre. Hedge funds often like to profit from the stampeding. In this case their shorting is shouting “Fire!” That’s usually easier to do when the theatre is actually burning.

“FDIC should change its policy and add a risk sharing component to its insurance.”

Very good idea. I am not sure if the depositors robbed the bank. The rate chasing could be seen as picking up the dollar bill that was lying on the street. You can’t blame the depositors for wanting any extra return they could get.

IndyMac basically said to its customers, “Hey, FDIC’s vault is wide open. Go grab some money.” Customers heeded the invitation and took some money home. Technically that’s not theft or robbery because FDIC opened the door for them. But the customers were certainly taking advantage of FDIC’s weak controls.

Outside of FDIC insured world, this never happens. Higher returns are accompanied by higher risks. That’s why I think we ought to introduce a little bit of risk sharing: a lower cap; or co-insurance (say 95% insured between $25k and $100k); or a deductible (first $500 is not insured).

Defaulted Borrowers?
“In the end, they took and kept the money from FDIC.”

?!?!?

As you said, these buyers were victims of [I believe criminal]
banking practices that intentionally deceived them.

Many of them have lost their homes and their life savings on
these corrupt deals and have long term credit problems to boot.
I have read several studies which indicated that many people
[in particular, but not exclusively refinancers] were qualified
for, or already in, a safer and less risky mortgage, but were steered
into sub-prime because the industry made much higher profits
that way. Financial industry skulduggery, who could believe it?

I fail to see how people who entrusted the financial and real estate
“experts” to give them accurate, fair, and honest advice and
now have lost their savings and/or home are the “robbers”.

Some of these people were taking out loans because they were
trying to repair their home or to pay for medical expenses [I’m not
talking about house flippers]. If they were in a regular mortgage
for a number of years and got steered into sub-prime refinance
and now have lost their home they were the ones that were robbed.

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